Yen in Play

The Japanese yen remains firm even as the other major currencies see their early gains pared. Many players have their sights set on the multi-year low set last Nov near JPY84.85.

There are several factors behind the yen's rise. Many will talk about the concerns about the world economic outlook. Others will emphasize the narrowing of interest rate differentials. Some may cite the fact that the finance minister seemed to ease the risk of intervention earlier today by noting that the yen's level is set by the markets.

What these factors have in common is that no attribute the yen's strength to domestic developments in Japan. In fact, the yen's strength may really reflect a particular weakness in Japan. The appreciation of the yen is a symptom of the private sector challenge in re-cycling the combination of its current account surplus and foreign purchases of Japanese assets.

That said, there are numerous reasons why the BOJ is unlikely to intervene. Some of these we noted yesterday, like relatively low volatility and no extreme reading in the premium that is being paid for yen calls over yen puts. In addition, we note that it does not seem like a case of yen strength as much as it is of dollar weakness, suggesting intervention on the bilateral pair may not be successful. Also, leaving aside the SNB's QE operations, the major industrialized countries have not intervened in the foreign exchange markets throughout the crisis, suggesting the bar to intervention is high.

However, another important argument against intervention is that the economic impact of yen appreciation is not particularly strong. Local press report that many of the large Japanese companies with significant external sales (not only exporters), are substantially revising their budget levels that were set at the start for the fiscal year for both euros and dollars. As companies announced these changes, several like Ricoh and Sony (examples not recommendations) also boosted their earnings guidance.

The yen's strength may aggravate the deflationary forces in Japan and that suggests that rather than intervene in the foreign exchange market, the MOF may intensify pressure on the BOJ to take additional steps, such as increasing its JGB purchases, or expanding existing lending facilities, to combat deflation.